Philip Morris International’s Second Quarter Earnings Rise on Pricing Gains, Slower Volume Decline

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Philip Morris International (NYSE:PM) reported higher second quarter earnings on July 17, as a result of pricing gains and slower decline in sales volume. Despite significant currency headwinds, the company reported an 8.5% year-on-year jump in earnings per share (EPS) adjusted for one-time items. EPS adjusted for the negative impact of a stronger U.S. dollar and special items grew 20% y-o-y. The company also guided for its 2014 full-year adjusted diluted EPS to grow by around 6-8% y-o-y. [1]

During the quarter, Philip Morris International’s total cigarette shipment volume declined by just 2.7% y-o-y, attributable to the decline in the overall global taxed cigarette market. However, the company was also able to realize meaningful consolidated pricing gains to more than offset lower volumes. Its revenue per cigarette, net of excise taxes, increased by ~1.2% y-o-y, while unit operating costs remained largely stable. This reflects Philip Morris International’s price-taking capability based on a healthy brand portfolio, which includes Marlboro, the number one cigarette brand worldwide.

Philip Morris International is a leading international tobacco company with its products sold in more than 180 countries worldwide. Until its spin-off in March 2008, Philip Morris International was an operating company of Altria Group (NYSE:MO). Excluding the U.S. and China, the company holds more than 28% of the total international cigarette market, led by its flagship brand Marlboro. We currently have a $79/share price estimate for Philip Morris International, which is ~16x our 2014 full-year GAAP diluted EPS estimate of $4.93 for the company.

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Slower Sales Volume Decline in the EU

The key highlight of Philip Morris International’s second quarter results was much slower than expected industry volume decline in the EU. The company, along with other international tobacco giants, had been struggling with the rapidly declining cigarette sales volume in the region for the past several quarters. Last year, total legal cigarette sales volume in the EU declined by 7.5% y-o-y, compared to just 2-3% decline in cigarette sales in Asia and Eastern Europe, the Middle East and Africa (EEMA) regions. [2]

However, Philip Morris International’s second quarter results show a marked improvement in the rate of decline of cigarette sales in the EU. According to the company, total cigarette sales in the region declined by just 1.2% y-o-y, compared to a decline of 8% y-o-y during the same period last year. The company attributed the sharp deceleration in industry sales volume decline in the EU to a slowdown in the growth of the e-vapor category, relatively lower out-switching by consumers to other tobacco products such as fine cut, lower price elasticity of demand for cigarettes and improved macroeconomic conditions in the region. Going forward, Philip Morris International expects the positive trend to continue and forecasts a much slower (3-5% y-o-y) average annual rate of decline in total cigarettes sales in the EU in 2015 and beyond. [3]

Regulatory Headwinds in Russia, Japan

While Philip Morris International’s cigarette sales volume rose by 2.4% y-o-y in the EU because of slower industry volume decline and a higher market share, its overall shipment volume actually declined by 2.7% y-o-y because of sharp indirect tax hikes in Russia and Japan. In Japan, a sharp 300 basis points hike in sales tax implemented at the beginning of the second quarter weighed significantly on tobacco sales in the country. According to Philip Morris International, total cigarette sales in the country declined by 14.4% y-o-y. [3]

On the other hand, in Russia, the company’s largest market in the EEMA region, tighter anti-tobacco regulations and sharp increases in indirect taxes on cigarettes continued to drag down tobacco sales. During the second quarter, the company’s sales volume in the country declined by almost 5% y-o-y as a result of the implementation of excise tax hikes in June last year and January this year. Apart from this, a new anti-tobacco bill that was signed into law on February 25, 2013, also came into effect in June last year. [4]

The new anti-tobacco law aims to reduce annual smoking-related casualties in Russia by half over the next decade, by restricting the marketing and sale of cigarettes, and smoking in public areas. Russia initially banned smoking at schools and universities, museums, sports facilities, hospitals and on public transport, but the bans were extended to cafes, restaurants and hotels in June this year. It also includes provisions for implementing a minimum price on cigarettes starting this year and banning tobacco sales at street kiosks. Therefore, the business environment in Russia is expected to continue to remain harsh for Philip Morris International for the rest of the year. The company expects total cigarette sales volume in Russia to decline by around 9-11% y-o-y this year. [4]

Negative Impact of Stronger U.S. Dollar

Philip Morris International sells cigarettes in more than 180 countries. Since the company operates primarily in local currency in these markets, a strengthening U.S. Dollar impacts its financial results negatively. The U.S. Dollar has strengthened significantly against many international currencies, especially the emerging market currencies, since the second half of 2013 when the U.S. Federal Reserve started scaling back its bond-buying program. According to historical currency charts provided by xe.com, the U.S. Dollar strengthened by around 15%, 10% and 5% y-o-y during the second quarter against Indonesian Rupiah (IDR)Russian Ruble (RUB)and Brazilian Real (BRL), respectively.

Strong currency headwinds dragged down Philip Morris International’s adjusted diluted EPS by $0.15 or ~11% during the second quarter. The company also guided for its 2014 full-year diluted EPS to be around 5.5-7.5% lower, compared to last year, as it expects the strengthening U.S. dollar to drag down its full-year earnings by $0.61 per share. It should also be noted that the depreciation of a local currency against the U.S. dollar might also lead to higher relative prices of Philip Morris International’s brands in the local market, thereby weakening its competitive positioning as well.

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Notes:
  1. Philip Morris International Reports 2014 Second Quarter Results, pmi.com []
  2. Philip Morris International SEC Filings, sec.gov []
  3. Philip Morris International Second Quarter Earnings Call Presentation, pmi.com [] []
  4. Philip Morris International Second Quarter Earnings Call Transcript, pmi.com [] []